A good credit score is a financial asset to have by itself. This allows one to seek financing for their projects with much confidence, and it has a positive effect on the possibility of the funding being approved by financial institutions.
However, the credit score is affected largely by the type of credit that a person has. This guide will delve into the installment loans vs revolving credit discussion and try to advise on which type of credit is most suitable to a person.
Additionally, the guide will explore the effect of each type of loan on a person’s credit score.
What Is An Installment Loan?
An installment loan is a type of secured or unsecured loan where an individual borrows a predetermined amount of money and then repays this amount over a given period. Interest will be charged on this borrowed amount, and the borrower will agree with the lender on how the borrower will pay back the loan in installments. The following are types of installment loans.
A secured installment loan is a loan which requires that you part up security as collateral for the loan being offered. This collateral can range from anything such as jewelry to a house or even a car. In this type of a loan, failure to pay means the lender has the right to claim the collateral and dispose of it to recoup their money.
An unsecured installment loan is a type of loan where no collateral is offered to the lender in return for the loan that the borrower receives.
This type of loan can be something like a soft loan from your friend Jake. Jake does not require that you give him security for him to offer you the soft loan. Usually, unsecured installment loans include very small amounts, usually below $5,000.
Some examples of installment loans that many people are familiar with our mortgage, auto loans, and student loans. In each one of these, an individual is awarded a certain amount of money.
This amount is then expected to be repaid in installments over some time. An interest rate is agreed upon, and the interest is also factored in the payment.
The reduction of the principal amount, which is the money that is lent out, is called amortization. Each installment, whether monthly or yearly, will include a certain amount that goes to amortization and the other goes to the interest and as the case dictates, taxes and insurance, for example for a mortgage.
Reading through this guide this far, one may be asking what is revolving credit? Moreover, how does it affect my credit score? Revolving credit is a special type of credit usually charged on a person’s credit card. What happens here is, each credit card has a set limit that a person can utilize. A person may or may not utilize the entire limit that they are provided.
The repayment for this type of loan is made differently. Unlike for an installment loan that requires one to pay off their entire loan amount plus interest before borrowing again, revolving credit does not work that way.
Here, one has a set threshold that they are supposed to pay monthly. A person can then decide whether to add on to this amount they are repaying or roll over the payment to the next month. In the meantime, the person is still allowed to borrow provided the set limit for the card has not been reached. The interest on the amount is charged as usual.
Installment Loans Vs Revolving Credit
Given an option to choose between these two types of credit, there is none in particular that credit score rating companies recommend. It favors one more if he or she has both of these accounts on the credit line. The main distinguishing factor will be in the repayment of each one of this credit.
Revolving credit loans are unsecured and therefore are charged higher interest and additionally have more rules guiding how one can be scored with regards to this type of loan. A credit utilization score is crucial in the credit score when revolving credit comes under consideration.
A person’s credit utilization is a percentage arrived at by looking at how much one has borrowed on their credit card against their loan limit. The higher this percentage is, the more the negative effects it has on a person’s credit score.
The inverse is true as well. Credit experts advise that the credit utilization be kept below 30%. Alternatively, if one has a very high credit utilization percentage, they can lower this by taking lower limit credit cards and spreading their overall credit limit across these cards.
The biggest risk with any loan is a failure to repay but, the effect that a $5,000 default on a mortgage installment has is not the same as a $5,000 default on a credit card. In the instance of a mortgage, the credit score will not be affected because the bank can make foreclosure and recoup their money.
In the instance of a credit card, this is not possible, and therefore the penalty is reflected on a person’s credit score. Factoring in all of these, it is right to say that installment loans are better than revolving loans. When it comes to revolving loans, repayments should be done to avoid defaulting while at the same time, the credit utilization needs to be checked on keenly.
Weighing in The Options
A person’s credit score is a crucial aspect of their finances. The advice of a professional should be sought while comparing installment loans vs revolving credit and before one commits to taking up debt.
The effort also needs to be made to learn more about the various types of credit and their effect on a person’s credit score.
Additionally, information and tips on how to improve a person’s credit score and to apply for a loan, please visit our website.